Life Insurance and Annuities R. B. Drennan , PhD Temple University May 20, 2013

The Griffith Insurance Education Foundation

INFORM+INSPIRE

Life Insurance and Annuities

R. B. Drennan, PhDTemple UniversityMay 20, 2013

2

Life Numbers…

How long will you live?

What is “life expectancy”?

Males/Females Today: M / F

Life Expectancy At Birth

Year Female Male

1850 40.5 38.3

1900 51.1 48.3

1950 71.7 66.0


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Mortality: Nature of the Loss (Premature Death)Meaning-- “Death with outstanding

unfulfilled financial obligations” Costs

Loss of earnings to family (Human Life Value) Final expenses (Liquidity Issue) Non-economic costs

Emotional loss, role models

Causes of death among young (~20) CA, S, OA, C


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Life Numbers…

Probability of death for 20-35 year-old: In U.S.:

X out of 1,000 $100,000 of LI coverage:

F * S .001 * $100,000 = $____ $1 per $1000 of face amount Price for pure protection


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Term Life Insurance Pricing

time

$orp(l)

mortality curve (~term)

100x


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Term Versus Permanent Pricing

time

$orp(l)

overpayment

underpaymentlevel

premium

mortality curve (~term)

100x


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Life Insurance Products Traditional

Term Life – no cash value Whole Life Endowment Annuities

Non-Traditional Universal Life Variable Life Variable Universal Life Variable Annuities


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Life Insurance Rate (Price) Development Mortality Experience and Rating Factors

Age (group 20 and 60 year-olds?) Male / Female Smoker / Non-Smoker Race? Unique Factors: Hobbies, Job, Foreign

Residence


Life Insurance Rate (Price) Development, cont. Loading (Net Rate vs. Gross Rate)

Expenses Taxes Contingencies Profit

Interest (Long-term contract)


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Objectives in Insurance Prices (Rates) Adequate

The payments generated by a block of policies plus any investment return on same must be sufficient to cover current / future benefits and costs

Equitable (not “unfairly” discriminatory) Refers to setting premiums commensurate with expected

losses and expenses; also suggests no cross subsidization. Sets a floor.

Not Excessive Sets a ceiling Competition Regulation


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Solvency Policing Statutory Accounting ( A = L + Surplus ) Minimum Capital and Surplus Requirements Annual and Quarterly Financial Statements Audited Statements Required Statements Signed by an Actuary Company Examinations

Every 3 to 5 years Coordinated within zones


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Solvency Policing Investment Restrictions

Type, quality, and quantity Insurers typically match assets and liabilities

Minimum Reserve Requirements Solvency Monitoring

Insurance Regulatory Information System (IRIS) FAST – Financial Analysis Solvency Tools Risk-Based Capital Requirements Ratings (Best, S&P, Weiss)

Holding Company Issues


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Consumer Protection Product and Price

Rate criteria (not inadequate, not excessive, not “unfairly” discriminatory)

Types of rating laws Prior approval MLR in health insurance

Policy forms (products)

Underwriting Agents and Brokers


Consumer Protection Unfair Trade Practices

Rebating, Twisting vs. Replacement Market Conduct Examinations Policy Forms - Contracts

Definition of key terms Grace period Incontestability Clause Surrender values Reinstatement


Taxation of Life Insurance Products Death Benefit

Not taxable to beneficiary No limit as to face amount True for all types of life insurance

contracts


Taxation of Life Insurance Products Cash Value Life Insurance [CVLI]

Product has two components Protection and savings or cash value Cash value accumulates over time –

credited with interest ‘Inside buildup’


Taxation of Life Insurance Products No federal income tax for a

policyholder with respect to any earnings on CVLI

True if the life insurance contract meets the definition of a life insurance contract under Section 7702 – must have the appropriate balance between death protection and cash value


Taxation of Life Insurance Products Policy Loans Borrow cash value – interest charged Interest is not deductible if policy is

Single Premium Whole Life or Endowment Contracts


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Annuities

•Oscar Wilde:– “…It is better to have a permanent income than

to be fascinating.”


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The Risk We’ve worked and saved $1 million The Risk: We might live a (really) long

time and outlive our assets In most countries:

65-year-old men and women can expect to live to 81 and 85

1/3 women and 1/5 men born today will live beyond 90


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How Long Will Retirement Assets Last?


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Life Insurance vs. Annuities

Think of as opposite of LI Life insurance addresses the risk of dying too

soon—mortality risk Annuities address the risk of living “too

long”—longevity risk


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Life Insurance vs. Annuities Over 50% of Life Insurer premiums today

are for annuities instead of LI—why the shift from when they were only 25%?

Basic Idea is: For every $100,000, 65-year-old can receive ~$700 in monthly income ($8,400 per year), for life.

Now, women receive more or less than men? And why?


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Annuities Defined Life Annuity

In return for a single premium or a series of premiums Provides a series of periodic payments to a named person Starting at a specified date (now or later) For life

…People always live forever when there is any annuity to be paid to them. Jane Austen


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Purpose of Annuities Purpose: to provide an income that cannot

be outlived Insurer takes on longevity risk and investment risk Annuitant / Payee takes on risk of dying too soon

Live to 104, good deal; Die in 6 months, not so good

Insurer not so concerned with poor health of applicants for annuities


One Product, Two Stages: A Deferred Stage, Then an Immediate Stage


Source: Black and Skipper, Life & Health Insurance, 13th edition, (Upper Saddle River, NJ: Prentice-Hall, 2000) p. 165.

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Annuities—Mechanics Longevity risk is pooled by insurer

Insurer can predict the approximate number of annuitants who will be alive at the end of each year

Some individuals will live long / short


Annuities—Mechanics The unliquidated contributions of those

who die early can be used to provide payments to those who live a long time – benefit of survivorship

Some people are uncomfortable with big “forfeit”—to be discussed shortly. Thus, few people annuitize, and even fewer annuitize without some form of minimum guarantee


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Annuity Settlement Options Cash option—lump sum or in installments for a period of time

Life annuity (no refund) – provides life income while annuitant alive; payments end at death

Highest periodic income But potential for big forfeiture

Life annuity w/ guaranteed payments Usually 5, 10, 15 or 20 years

In general, monthly benefit is related to risk borne by annuitant versus insurer


30The Griffith Insurance Education Foundation

Deferred Annuities,Classified by Underlying Investment

DeferredAnnuities

Fixed

TraditionalFixed Indexed

Variable

TraditionalVariable

With GuaranteedMinimumBenefits

Fixed Annuities Traditional Fixed

Guaranteed ROR at the time of purchase No investment risk for the purchaser More safety Tradeoff – ROR is very modest


Fixed Annuities Indexed Annuities

Splits the difference between a fixed and variable annuity

Fixed guaranteed minimum ROR Variable ROR tied to S&P Market Index

or some other barometer of investment growth

Can participate in the market while still protecting their principal


Variable Annuities Traditional Variable

Ties the growth of the annuity to stock and mutual funds

No guarantees offered by the insurer


Variable Annuities Variable with Living Benefit Option

Guaranteed minimum benefits Guaranteed benefits for life Guaranteed minimum ROR Opportunity for a portion of their funds to

be invested at a potentially higher ROR



Annuity Regulation Currently, Who Regulates What?


States Regulates Fixed and Variable Annuities

• Annuities are insurance products because,in their immediate annuity stage, they involve “life contingencies” This means the benefit depends on how long

someone lives As insurance products, they are regulated by

the states State regulation of annuities covers

• Minimum reserves• Contract provisions• Market conduct standards


Currently, the SEC Regulates Variable Annuities

The SEC considers a variable annuity an investment, not an insurance product

Because the annuity owner retains the investment risk (unlike a fixed annuity, in which investment risk is transferred to the insurance/annuity company)

SEC regulation is in addition to state securities regulation, but states typically copy SEC requirements

SEC regulation of annuities covers • Market conduct standards


Who Regulates Indexed Annuities?• Indexed annuities are fixed annuity products-

When interest is credited, the credit is determined by the annuity company.

The determination uses a formula that the company can change.

The formula uses an external index, often the S&P 500

• As fixed annuity products, they’re currently regulated by the states

Who Regulates Indexed Annuities?

• Even though indexed annuities Determine investment growth by reference to a

stock market index, and May be sold partly on the “upside potential,”

they’re not currently regulated by the SEC This issue is a matter of debate –

Rule 151(a)



Summary of Annuities

Annuities are financial products that many people find hard to understand

Regulators have been concerned that some people are buying annuities that are unsuitable for them – particularly variable annuities

Indexed annuities are still regulated by the states but have been proposed to be regulated by the SEC

Regulation will differ depending on which suitability model is relied on


Life Insurance and AnnuitiesThank you For more information contact:

The Griffith Insurance Education Foundation7100 North High Street, Suite 200Worthington, Ohio 43085

Phone: 855-288-7743Email: [email protected]

Life Insurance and Annuities R. B. Drennan , PhD Temple University May 20, 2013

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